Democratic Senators and the Buyback Boogeyman

Jesse Fried is the Dane Professor of Law at Harvard Law School and Charles C.Y. Wang is the Glenn and Mary Jane Creamer Associate Professor of Business Administration. This post was authored by Professor Fried and Professor Wang. Related research from the Program on Corporate Governance includes Short-Termism and Capital Flows by Professor Fried and Professor Wang (discussed on the Forum here).

Last month, Senator Chuck Schumer, along with Senator and presidential candidate Bernie Sanders, declared they would introduce “bold” legislation to prohibit a public firm from repurchasing its own stock, unless the firm first invests in employees and communities, including paying workers at least $15 per hour and offering “decent” pension and health benefits. Welcome to Washington’s newest political ritual: Senators seeking to demonstrate their concern for workers by proposing bills that severely restrict—or even outlaw—buybacks. Unfortunately, these proposals appear motivated by misleading measures of corporate capital flows, as well as on a profound misunderstanding of how the U.S. economy works. If enacted, such bills could threaten not only the capital markets but the employees and communities the Senators claim to care about.

Leading Senate Democrats appear to believe that repurchases, when added to existing levels of dividends, harm workers and impair long-term investment by starving firms of needed capital. The Schumer-Sanders bill would join legislation introduced by Schumer and Senator Tammy Baldwin to give the Securities and Exchange Commission authority to reject buybacks that, in its judgment, hurt workers. It also would require boards to “certify” that a repurchase is in the “best long-term financial interest of the company.” Senator Baldwin has introduced another bill, co-sponsored by Senator (and presidential candidate) Elizabeth Warren that goes even further: It bans all open-market repurchases.

The accepted wisdom among the Democratic leadership is flat out wrong; there is simply no evidence that the overall volume of corporate payouts to shareholders, through repurchases and dividends, is excessive. Buyback critics, including Schumer and Sanders, say that S&P 500 firms don’t have enough investment capital because dividends and repurchases routinely exceed 90% of their net income. Between 2007 and 2016, for example, these companies distributed $7 trillion to shareholders, mostly via repurchases. That was 96% of total net income. But our research shows that public firms recover from shareholders—directly or indirectly—about 80% of the capital distributed via repurchases. Shareholders return this capital by buying newly issued shares, mostly from employees paid with stock, but also directly from firms. Taking into account all types of equity issuances, net shareholder payouts in S&P 500 firms during the decade 2007-2016 were only about $3.7 trillion, or 50% of total net income. We analyzed the latest data available and found this pattern persisted through the third quarter of 2018, after the Trump tax cut had gone into effect.

Consider Microsoft. Between 2007-2016, it distributed $188 billion through buybacks and dividends—more than almost any other public firm—but also simultaneously issued $49 billion of equity to shareholders, making its net shareholder payouts only $139 billion.

At this level, net shareholder payouts don’t appear to impair investment capacity or firms’ ability to pay workers. Indeed, our research shows that total capital expenditures as well as R&D expenditures by public firms are both at the highest level ever. Moreover the intensity of investment intensity at public firms, measured by the ratio of capital expenditures and R&D to revenue, has been rising over the past 10 years and is near peak levels not seen since the late 1990s. In fact, R&D intensity at public firms recently reached an all-time high.

One might argue that firms would invest or pay workers even more if they had more cash at their disposal. But there is no shortage of cash. During 2007-16, cash balances at S&P 500 firms also rose by 50%, reaching around $4 trillion, providing ample dry powder for additional expenditures. By the end of Q3 2018, these stockpiles had reached $4.5 trillion, even after the increase in corporate buybacks following the tax cut.

Again, consider Microsoft. Despite $139 billion in net shareholder payouts between 2007 and 2016, Microsoft doubled its annual R&D and capital expenditures—from $10 billion to $20 billion—and boosted its workforce by over 40%. Meanwhile, Microsoft’s cash balances grew $90 billion to a whopping $113 billion. By the end of 2017, these balances had reached $143 billion. Given capital needs elsewhere in the economy, the remarkable level of idle cash at Microsoft and other firms suggests that net shareholder payouts are not too high, but may actually be too low.

The various proposals to restrict or ban repurchases would make it harder for public firms to return this surplus capital to investors. Indeed, that is the whole point. But the problem with damming up these funds in public companies is that young and growing private firms, which collectively require enormous amounts of equity capital, will find it harder to obtain financing. Private firms are vital to the U.S. economy. They account for more than 50% of nonresidential fixed investment, employ almost 70% of U.S. workers, and generate nearly half of business profits. And historically, private firms funded by VC and PE funds, including Silicon Valley start-ups, have generated tremendous innovation and job growth in the United States, including many high-paying jobs. Forcing large public firms to retain funds they cannot profitably deploy will make it harder for these potentially fast-growing firms to firms hire more employees, pay higher wages, and invest in their communities.

To be sure, firms could respond to restrictions or a ban on buybacks by issuing larger dividends. If firms can easily substitute dividends for repurchases, there will in fact be little harm. But once Congress has begun making decisions about capital allocation, why would it want to limit itself to repurchases? Indeed, even before their anti-buyback legislation has been introduced, Schumer and Sanders have indicated that policymakers should also “seriously consider” proposals to limit the payout of dividends. If Congress goes down this road, large public companies will mis-invest and mis-spend their excess cash, and private firms will be deprived of much needed growth capital. Stock prices will decline, 401(k) savers will be hurt, and IPOs will dry up: who would invest in a public firm if future profits will not be returned to investors?

Moreover, once federal legislators give themselves the authority to decide how much public firms can distribute to investors, they will be tempted to add more mandates and restrictions, ostensibly to address other “problems” in corporate America, but actually to benefit key electoral constituencies and contributors. Crony capitalism will replace real capitalism. Let’s hope Schumer and his Senate colleagues don’t lead us down this path.

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One Comment

  1. Bill Evans
    Posted Wednesday, March 13, 2019 at 11:13 am | Permalink

    Clear, succinct explanation. To be compelling to an informed audience, it would be helpful if this piece discussed dividends as a (costly from a tax perspective) substitute to buy backs.

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